Pavilion: New REIT on the block

THE Pavilion Real Estate Investment Trust (REIT) made a solid debut on Bursa Malaysia last week. The trust unit rose as high as RM1.04 and was the most actively traded counter on its first day of trading. It has since retraced slightly to RM1.02, but remains comfortably above the initial public offering (IPO) price of 90 sen.

Interest in the REIT is unsurprising given prevailing uncertainties in Europe and the potential impact on the health of the global economy. Currently, the general consensus is that the global economy will continue to grow in 2012, albeit at a slower pace. However, the eurozone debt crisis remains a wild card and further deterioration in the situation could throw even modest expectations into disarray.

Meanwhile, the latest 3QFY11 earnings reporting season for companies listed on the local bourse was muted, weighed down by the gloomier outlook. A fair percentage of results have fallen short of expectations and we could see further earnings downgrades over the next few months.

As such, many investors are staying on the defensive, picking companies with more resilient businesses and earnings as well as higher than market average dividend yields. In view of the slowing economic growth, interest rates are unlikely to head higher anytime soon. In fact, central banks have started to loosen monetary policy in recent days. REITs are among the highest yielding instruments on the local bourse and most have fairly low beta relative to the broader market.

Portfolio valued at RM3.54 billion Pavilion REIT's portfolio consists of only two properties — Pavilion Kuala Lumpur Mall and Pavilion Tower — valued at a combined RM3.54 billion.

Pavilion Mall is the among the few premium fashion shopping malls in the country, catering for the mid- to high-end segment of the population. The shopping centre also attracts more than its fair share of tourist numbers, thanks to its location in the heart of the Golden Triangle and commercial business district.

The shopping mall is valued at RM3.42 billion and has a total net lettable area of almost 1.34 million sq ft. Occupancy rate for Pavilion Mall has averaged above 98% over the past four years.

Pavilion Tower is a 20-storey office block connected to the mall. Contributions from Pavilion Tower are small relative to the REIT's total revenue.

The trust intends to stay focused on properties used solely or predominantly for retail purposes. It has the rights of first refusal for two other shopping malls — fahrenheit88 (located across the street from Pavilion Mall) and a yet-to-be developed mall in Subang Jaya — as well as for the future expansion of Pavilion Mall.

This retail property market segment is, arguably, among the most resilient given that consumer spending is expected to remain fairly robust despite the global financial turmoil. Indeed, rental rates for well-managed and well-located shopping malls have been trending higher, even through the 2008 global financial crisis.

This, compared to say, earnings risks for REIT exposed to the commercial market segment are perceived to be higher on the back of expectations of excess office space supply coming onto the market in the next few years.

Comparing retail-focused REIT There are now 15 REIT listed on the Bursa Malaysia. Aside from Pavilion REIT, some of the other primarily retail-focused REIT are Sunway REIT, CapitaMalls Malaysia Trust (CMMT) and Hektar REIT.

In terms of total asset size, Pavilion REIT is second only to Sunway REIT. While the shopping mall accounts for nearly all of Pavilion REIT's turnover, Sunway REIT has a more diversified portfolio. Retail properties account for roughly 73% of the latter's turnover with the largest earnings contributor being Sunway Pyramid Shopping Mall in Bandar Sunway, an 324ha integrated township in the Klang Valley. The hospitality and office sectors contribute the remaining 17% and 10% of turnover.

Both CMMT and Hektar are pure retail-focused REIT. The former owns four shopping malls, including Sungei Wang Plaza, just a stone's throw away from Pavilion Mall. The shopping centre is one of the oldest in the country but has continued to draw traffic despite the sharp increase in the number of newer malls.

CMMT has done quite well since its listing in July 2010, currently trading at around RM1.40 per unit compared with its IPO institutional price of RM1.

Hektar owns three shopping malls — Subang Parade, Mahkota Parade in Malacca and Wetex Parade in Muar — valued at a combined RM752 million.

Pavilion REIT intends to distribute all of its income from the listing date through December 2012. Based on its forecast earnings, distribution per unit is estimated at 5.73 sen next year. That translates into gross yield of roughly 5.6% based on the prevailing price of RM1.02, in line with our estimated yield for CMMT but lower than that for Sunway REIT and Hektar.

Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.